On 9 May 2024, the Financial Conduct Authority (FCA) published Market Watch 79.

In this edition of Market Watch the FCA discusses:

  • Failures of market abuse surveillance caused by issues with factors such as data and automated alert logic.
  • The FCA’s recent peer review of firms’ testing of front-running surveillance models.  

Market abuse surveillance and data governance, surveillance failures and model testing peer review

The FCA reminds firms that under the UK Market Abuse Regulation (UK MAR), firms must identify and report instances of potential market abuse. The FCA emphasises that a firm must have effective arrangements, systems and procedures in place to detect and report suspicious activity. These should be appropriate and proportionate to the scale, size and nature of their business activities.

The FCA has become aware of problems with surveillance alerts not working as intended and assumed by the firm. To help firms understand the types of issue they may face, the FCA sets out examples of malfunctions they have observed.

FCA’S peer review of firms’ testing of front-running surveillance models

The FCA also outlines the key findings of its peer review of how investment firms review their automated surveillance models. The FCA found that most firms reviewed had formal procedures describing:

  • The frequency of testing.
  • Which elements of the model were subject to review.
  • The form of the review.

The remainder had no formal process or a semi-formalised process.

Most firms undertook an annual test of some type. The different types of testing were:

  • Parameter calibration.
  • Model logic.
  • Model code.
  • Data (comprehensiveness and accuracy).

Approximately half the firms focused their reviews mainly on parameter calibration. Some firms used a risk-based approach, where the frequency of testing varied depending on the inherent risk of the relevant market abuse type. Calibration testing was also sometimes/in many cases split from reviews of logic, coding and data, with the former generally more frequent.

The number of surveillance models deployed by reviewed firms for client order front running varied, depending upon factors such as:

  • The range of asset classes for which they were deployed.
  • The degree of tailoring of parameters that was applied inter and intra asset classes. 

The Market Watch then highlights that the following should be considered by firms as part of their governance processes around market abuse:

  • Assets traded.
  • Actors involved.
  • Trading methods.
  • Venues accessed.
  • Other factors.

Steps to avoid surveillance failures

The FCA then sets out steps that firms may wish to consider in order to avoid surveillance failures covering data governance, model testing and model implementation and amendment.

What firms can do

In the final part of Market Watch the FCA describes some things that firms can do. For example:

  • Appropriate tailoring of alert models.
  • Testing by the second line and internal audit.
  • Adequate focus and resource to governance arrangements.
  • Vigilant approach to proactively guard against surveillance failures and mitigate relevant risks.
  • Developments such as the use of artificial intelligence need to be accompanied by governance that keeps pace and remains effective.